JAMES FLANIGAN

U.S. Responds to Latin America's Distress With Firm Self-Interest

Once again Latin America is in financial distress. The United States is ready to back Mexico with up to $40 billion in loan guarantees. Elsewhere, governments and industries in Brazil, Argentina and Chile nervously watch stock markets and currency exchanges to see if foreign investment will come in or flow out--and thus determine whether their economies will go forward or backward this year.

Meanwhile, U.S. small investors--who wouldn't know the capital city of some of these countries--watch their "emerging markets" mutual funds dwindle in value and wonder: Why do Latin economies always seem poised on a banana peel?

And why should we care? Self-interest to start with. U.S. companies already do a lot of profitable business in Latin America, supporting jobs in the United States. And Latin America has the potential to make the U.S. market hemisphere-wide--and three times its present size.

Only a month ago, at the summit of 34 Western Hemisphere nations in Miami, a free trade agreement was signed that would take effect by 2005 and cover all 750 million people of the Americas. A new era of prosperity was declared, prematurely but prophetically.

We also should care because there is much Americans can learn from Latin America--about the importance of savings, of reducing budget deficits and of a stable, democratic society.

The first thing to realize is that Latin economies are small. Brazil, geographically the fifth largest country in the world, with 155 million people, has annual economic output of roughly $400 billion--or only as much as Los Angeles and its four neighboring counties of Southern California.

Argentina, with 34 million people, has more than $100 billion in gross domestic product; Chile with 14 million people has $35 billion. Stocks and bonds of those three countries, along with Mexico, make up the bulk of the Latin American portion of U.S. investment funds.

"They are the fastest growing economies outside of Southeast Asia, growing 4% to 5% a year" notes Robert Gay, an economist and investment manager who covers Latin America for Bankers Trust.

But it is fragile growth. For the most part, Latin countries depend on foreign investment for the capital to modernize their industry. The equation is simple, explains economist Michele Santo of Montevideo, Uruguay: "If investors in the rest of the world are not willing to supply the capital, expenditures by industry and by government in most Latin American countries will be reduced."

That means fewer Ford cars and tubes of Colgate toothpaste purchased, because Latin countries are ready consumers of U.S. goods.

But why must it be foreign investment? Why don't Latin business people invest in their own economies, as business does elsewhere--including the developing countries of Asia?

The answer is that local business does invest, but not for the long term. "They invest in their own countries the way we do, nervously and for the short term," says Gay. So when there is a threat to political stability or the economy, capital takes flight to investments or bank accounts in other countries. Huge Mexican investments in Texas are a tradition.

For that situation, blame a history of instability. Just consider Argentina. Potentially one of the world's richest countries, with abundant agriculture and natural resources, Argentina fell into disarray four decades ago, first under rule by dictator Juan Peron and then by military rulers who took dissenters up in airplanes and threw them out. Such policies do not encourage confidence and investment.

In addition, inflation has been chronic in some countries--Brazilian inflation has run at 5,000%. And that destroys savings and mocks investment.

But things are changing. Latin countries are trying to discipline their economies, taking tips from Asian nations. The model is Japan after World War II, where the government used tax breaks to encourage savings, which it then funneled to industry. Tokyo also discouraged consumer spending by restricting imports, running the economy instead for industry, jobs and exports. That may not be ideal, but it's what poor countries often do to grow rich.

Chile is following that example today, with a mandatory pension plan that orders all employees to deposit 10% of their earnings in pension accounts. The Chilean government doesn't run budget deficits, and it discourages short-term foreign investment in financial markets while welcoming long-term foreign investment in plants and equipment. It lives within its means, say economic experts, and its economy is now the most respected in Latin America.

Others are trying to reform. Argentina has tied its peso directly to the dollar, hoping to control inflation by refusing to print more pesos than it can back with dollars. Mexico may have to adopt that strategy. And Brazil is making a similar attempt under new President Fernando Henrique Cardoso. So far it has reduced inflation to about 18%.